Chic Cycle Inc., has two divisions, A and B, that manufacture expensive bicycles. Division A produces the bicycle frame, and division B assembles the rest of the bicycle onto the frame. There is a market for both the subassembly and the final product. Each division has been designated as a profit center. The transfer price for the subassembly has been set at the long-run average market price. The following data are available for each division: Selling price for final product $320
Long-run average selling price for intermediate product 225
Incremental cost per unit for completion in division B 140
Incremental cost per unit in division A 120
The manager of division B has made the following calculation:
Selling price for final product $320
Transferred-in cost per unit (market) $225
Incremental cost per unit for completion 140 365
Contribution (loss) on product $(45)
1. Should transfers be made to division B if there is no unused capacity in division A? Is the market price the correct transfer price? Show your computations.
2. Assume that division A's maximum capacity for this product is 1,500
units per month and sales to the intermediate market are now 1,000
units. Assume that for a variety of reasons, division A will maintain the $225
selling price indefinitely. That is, division A is not considering lowering the price to outsiders even if idle capacity exists. Should 500
units be transferred to division B? At what transfer price?
3. Suppose division A quoted a transfer price of $180 for up to 500 units. What would be the contribution to the company as a whole if a transfer were made? As manager of division B, would you be inclined to buy at $180?
Explain.
4. Suppose the manager of division A has the option of (a) cutting the external price to $220,
with the certainty that sales will rise to 1,500 units, or (b) maintaining the external price of $225
for the 1,000 units and transferring the 500 units to division B at a price that would produce the same operating income for division A. What transfer price would produce the same operating income for division A? Is that price consistent with that recommended by the general guideline so that the resulting decision would be desirable for the company as a whole?